Estimating a time-varying financial conditions index for South Africa

Abstract

This paper uses 39 monthly time series of the financial market observed from January 2000 to April 2017 to estimate a financial conditions index (FCI) for South Africa. The empirical technique used is a dynamic factor model with time-varying factor loadings proposed by Koop and Korobilis (Eur Econ Rev 71(C):101–116, 2014) based on the principal component analysis and the Kalman smoother. In addition, we estimate a time-varying parameter factor-augmented vector autoregressive (TVP-FAVAR) model, which includes, in addition to the FCI, two observed macroeconomic variables. The results show the ability of the estimated FCI to predict risks in the financial market emanating from both the domestic market and the global market. Furthermore, the TVP-FAVAR model outperforms the constant-loading factor-augmented vector autoregressive model and the traditional vector autoregressive model in the out-of-sample forecasting of the inflation rate and the real gross domestic product growth rate. Finally, tighter financial conditions contract the real economy and are deflationary at the same time. Importantly, the responses of macroeconomic variables are asymmetric and vary over time.

Appendix

See Fig. 12.

List of variables

No.	Description	Definition	Frequency	Transformation	Source
Credit market
1	All monetary institutions	Credit (Total loans and advances) extended to the domestic private sector	D	5	S
2	R186 10.5% (2026)—Government stock	Government stock	D	2	S
3	Yield Market: Eskom bonds and T-bill	Eskom bonds—91-day Treasury bill	D	1	S
4	Yield Market: 0–3-year government bond and T-bill	0–3-year government bond—91-day Treasury bill	D	1	S
5	Yield Market: 3–5-year government bond and T-bill	3–5-year government bond—91-day Treasury bill	D	1	S
6	Yield Market: 5–10-year government bond and T-bill	5–10-year government bond—91-day Treasury bill	D	1	S
7	Yield Market: Long-term government bond and T-bill	Long-term government bond—91-day Treasury bill	D	1	S
8	Secondary Market: JSE All Bond yield	JSE All Bond yield	D	2	S
9	Differential between repurchase rate and T-bill	Differential between repurchase rate—91-day Treasury Bill	D	1	S
10	Margin between prime rate and 3-month Negotiable certificates of deposits (NCDs)	Prime rate—3-month NCD’s	D	1	S
11	Margin between 3-month NCD’s and Reserve Bank debentures	3-month NCD—Reserve Bank debentures	D	1	S
FX market
12	South African (SA) rand against US dollar (ZAR)	Exchange rate: SA rand against US dollar	D	5	S
13	Nominal effective exchange rate of the rand—20 trading partners: Effective Jan. 2010—Trade in manufactured goods	Nominal effective exchange rate of the rand	D	5	S
14	FX crash	$FXcrash_{t}=\frac{x_{t}}{\max \left[ x_{t}\in \left( x_{t-i}|i=1,\ldots ,12\right) \right] }$	D	1	S
Real estate market
15	South Africa: ABSA House Price Index (SA, 2000=100)	House Price Index as calculated by commercial bank ABSA	M	5	S
16	FNB house prices	House prices as calculated by First National Bank	M	5	S

Foreign market
17	US 3-month LIBOR	3-month LIBOR of the USA	D	2	B
18	US 90-day T-bill rate	90-day Treasury bill rate of the USA	D	2	B
19	TED (US)	3-month LIBOR—US 90-day Treasury bill rate	D	1	B
20	VIX	CBOE Volatility Index	D	1	B
21	S&P 500 stock in gold index	S&P 500 stock in gold index	D	5	B
22	Oil price in US dollars (Brent crude)	Price of Brent Crude oil in US dollars	D	5	B
23	Gold price—London (US dollar)	Gold price	D	5	B
24	Global total return index	Global total return index	D	5	B
Funding market
25	Negotiable certificates of deposits (NCDs): 3 months	3-month NCDs	D	2	S
26	Negotiable certificates of deposits (NCDs): 6 months	6-month NCDs	D	2	S
27	Negotiable certificates of deposits (NCDs): 12 months	12-month NCDs	D	2	S
28	Prime overdraft rate and T-bill	Prime overdraft rate—91-day Treasury bill	D	1	S
29	Interbank funds and T-bill	Interbank funds—91-day Treasury bill	D	1	S
30	Bank rate and average and fixed repo rate	Bank rate/fixed repo rate	D	2	S
31	TED (SA)	3-month JIBOR—SA 91-day Treasury bill rate	D	1	A
32	Financial beta	$\beta _{\mathrm{fin}}=\frac{{\hbox {cov}}\left( r_{\mathrm{fin},t}|_{t-1}^{t},r_{\mathrm{JSE},t}|_{t-1}^{t}\right) }{{\hbox {var}}\left( r_{\mathrm{JSE},t}|_{t-1}^{t}\right) }$	D	1	A
33	Bank beta	$\beta _{\mathrm{bank}}=\frac{{\hbox {cov}}\left( r_{\mathrm{bank},t}|_{t-1}^{t},r_{\mathrm{JSE},t}|_{t-1}^{t}\right) }{{\hbox {var}}\left( r_{\mathrm{JSE},t}|_{t-1}^{t}\right) }$	D	1	A
Equity market
34	Stock crash	${\hbox {Stockcrash}}_{t}=\frac{x_{t}}{\max \left[ x_{t}\in \left( x_{t-i}|i=1,\ldots ,12\right) \right] }$	D	1	A
35	All-Share (J203) Price Index	All-Share Price Index	D	5	S
36	Financials (J580) Price Index	Financials Price Index	D	5	S
37	Banks (J835) Price Index	Banks Price Index	D	5	S
38	All-Share total return (J203T) Price Index	All-Share total return Price Index	D	5	S
39	General Mining (J154) Price Index	General Mining Price Index	D	5	S
Macroeconomic activity
1	GDP	Nowcast of GDP growth	M	1	A
2	Inflation	Year-on-year change in consumer prices	M	1	S
3	Industrial production growth	Year-on-year change in industrial production	M	1	W
X	Prime overdraft rate	Benchmark rate at which private banks lend out to the public.	M	1	S

1. Frequency: D = Daily, M = Monthly. Note variables with daily frequencies have been averaged to monthly frequencies
2. Transformation: 1 = Level, 2 = First difference, 5 = First log difference
3. Source: A = Author’s calculation, B = Bloomberg, S = South African Reserve Bank, W = World Bank Global Economic Monitor dataset

Fig. 12

Baseline FCI and FCI using industrial production growth. The figure represents our baseline FCI constructed using our nowcast GDP (FCI) and the FCI constructed using industrial production growth (FCI_IP). Since the FCIs are standardised, values above 0 indicate stress in the financial market, while those below represent an ease of financial tensions. The FCIs have a high correlation coefficient of 99.22%